Taxable Income Components
Taxable Income = Net Revenue
– Gross operating expenses
– state/local production taxes
– depreciation
– depletion
Federal Taxes = Taxable Income * Federal Tax Rate

Operating Expenses Components
Field Personnel
•
Time of pumper, roustabouts etc dedicated to lease
•
Typically expressed as $/month
Utilities
•
Expendables such as electric or gas costs
•
Typically accounted as $/KW or $/mmbtu, however usually expressed as
$/month
Workovers
•
Costs for remedial expense type work; e.g., rod parts, pump changes
•
Typically incur cost as $/event where one workover per year.
Water disposal
• Costs incurred for water hauling and disposal.
• Expressed as $/bbl. Sensitive to method: truck hauling and disposal is $0.50-
1.00/bbl; but disposal directly into a SWD well or injection well is $0.05 –
0.15/bbl.

Operating Expenses
• On a per barrel basis:
$2(excellent)
$3 (good)
$6 (poor)
• On a monthly basis:
Flowing well
Pumping well
High volume wells
Gas wells
General estimates
$/month/well
$500-$1000
$1000
$1500-$2000 (subs, GL)
<$500

Operating Expenses Economic Limit
Net operating Revenue = Gross Operating Expenses + Sales Taxes

(bopd) * (oilprice) * (NRI)

(mcfd) * (gasprice) * (NRI)

*

1

Advol

* (1

Sev)

(GOE) * (WI) where,
NRI
WI
GOE
= net revenue interest in lease (less royalty)
= working interest in lease
= gross operating expenses, $/day
Oilprice
Gas price
Advol
Sev
= sales price, $/bbl
= gas price, $,mscfd
= local tax rate on revenue, tax $/revenue$, decimal
= state tax rate on revenue, tax$/revenue$, decimal

Depreciation
Asset depreciation
Economic physical functional
Book
Accounting
Tax
For calculating taxes to IRS

Depreciation Factors
• Depreciable property must be:
– Used in business or held for production of income
– Have a definite service life
– Something that loses value over time
• Cost basis
– Represents the total cost that is claimed as an expense over the asset’s life; i.e., the sum of the annual depreciation expenses.

Depreciation MACRS
•
M odified A ccelerated C ost R ecovery S ystem developed by IRS and approved by Congress to provide a simple and rapid depreciation method.
– Guidelines were set which created several classes of assets, each with an arbitrary life called a recovery period – not related to useful life.
– Prescribed depreciation rates for each class
– Under MACRS the salvage value of a property is always treated as zero.

Depreciation
Recovery ADR* Asset
Period midpoint class
3-year ADR < 4
Speical tools for manufacture of plastic products, fabricated metal products and motor vehicles
5-year
7-year
27.5-year
4<ADR<10
Autos, light trucks, high-tech equipment, equipment used for R&D, computerized telephone switching systems
10<ADR<16 Manufacturing equipment, office furniture, fixtures
10-year 16<ADR<20 Vessels, barges, tugs, railroad cars
15-year 20<ADR<25
20-year 25<ADR
Waste-water plants, telephone distribution plants or similar utility property
Municipal sewers, electrical power plant
Residential rental property
39-year
Nonresidental real property including elevators and escalators
* ADR: Asset Depreciation Range, published by IRS
MACRS

Depreciation MACRS
• Half year convention
– Assumes assets in place by midyear, thus only half year depreciation in first year
– Full year depreciation in subsequent years
– Remaining half year’s depreciation taken in the final year
• Depreciation methods
– Declining balance to straight line

Depreciation
MACRS
Year
7
8
9
10
11
4
5
6
1
2
3
3
Class
5 7
Depreciation rate in percent
33.33
44.45
14.81
7.41
20.00
32.00
19.20
11.52
11.52
5.76
14.29
24.49
17.49
12.49
8.93
8.92
8.93
4.46
Bold represents year switch from declining balance to straight line
10
10.00
18.00
14.40
11.52
9.22
7.37
6.55
6.55
6.56
6.55
3.28

Depletion Description
If you own mineral property such as oil, gas geothermal or standing timber, you may be able to claim a deduction as you deplete the resource. A capital investment in natural resources needs to be recovered as the natural resources are being removed and sold. The process of amortizing the cost of natural resources in accounting periods is called depletion .
The objective of depletion is the same as that for depreciation; i.e., to amortize the cost in a systematic manner over the asset’s useful life.
There are two methods to determine depletion: cost depletion and percentage depletion . These methods are used for book as well as tax purposes. In most instances, depletion is calculated by both methods and the larger value is taken as the depletion allowance for the year. For most oil and gas wells, only cost depletion is allowable.

Depletion Cost depletion
• Same concept as units-of-production method
• Generally more favorable for taxpayer
D

B

P
P

R
• D – annual cost depletion allowance, $
• P – oil or gas production sold or for which payment was received during the tax year.
• R – remaining reserves at the end of the tax year
• B – “adjusted basis” of property

Depletion Cost depletion example
Peters oil purchases a waterflood at $3 per recoverable barrel. If reserves are
146,000 BO, then the initial investment is $438,000. Calculate the annual cost depletion allowance for the production schedule below.
R = 146,000
Year
1
P, Mstb
46
Depletion allowance,
D, $
138
B = $438,000
2 35 105
3
4
5
6
7
25
15
10
8
7
75
45
30
24
21
Sum = $438,000

Depletion Percent Depletion
• Requires no starting basis
• Simply percentage deduction based upon net income from the sale of production from the property
• Allowed to small independents only….1000 bopd or 6000 mcfd, net
• Depletion rate for oil and gas wells, 15%
• Sum limited to 50% of a company’s taxable income from the property excluding the depletion deduction.

Depletion
Net revenue (less royalty)
Operating Expenses
Income (BFIT) depletion allowance, 15% of net revenue
Allowable limit, 50% of taxable income
Depletion allowance
Taxable Income (BFIT)
A, $M
973
438
535
146
267
146
389
Percent Depletion Example
B, $M
973
876
97
146
48
48
49